Inflation Hysteria and the Fed

by Scott Brown of Raymond James, 5/17/21

Chief Economist Scott Brown discusses current economic conditions.

The CPI rose more than expected in April, adding to inflation worries. The University of Michigan’s Consumer Sentiment index dipped in the mid-March reading, reflecting growing concerns about inflation and potential rate hikes. Yet, Fed officials, while acknowledging risks, have remained calm.

The Consumer Price Index rose 0.8% (+4.2% y/y) in April. The index for used motor vehicles jumped 10.0% (+21.0% y/y), accounting for more than a third of the increase. Motor vehicle production ground to a halt a year ago and sales to rental car agencies dried up during the pandemic. As a consequence, retail agencies had fewer vehicles to sell into the used car market this spring. The semiconductor shortage has crimped auto production recently, although the price index for new vehicles has risen only moderately (+0.5% in April, +2.0% y/y). The important point is that used vehicle prices are not going to rise sharply month after month.

The increase in year-over-year inflation reflected two other factors. Inflation figures were very low a year ago (the CPI rose 0.3% y/y in April 2020). Such “base effects” will last a little longer (the CPI rose 0.1% y/y in May 2020 and +0.6% y/y in June 2020), but they will fade in the months ahead. The other factor is restart inflation pressures as the economy recovers.

Supply chains take a while to get going in every recovery. However, given the nature of the pandemic and the expected speed of the economic rebound, these pressures will be more pronounced than typical. However, supply chain issues will work themselves out over time. February’s bad weather disrupted supply chains, but we’ve already seen a recovery from that. Freight costs have risen, but should stabilize and begin to moderate.

Labor issues will be a factor in the near term. There were going to be frictional challenges in matching millions of unemployed workers to available jobs. A lot of that is informational. Unemployed workers may not know where the jobs are and firms may not know where to find workers – and there may be regional issues (too many unemployed here, too many job vacancies there).

Some have cited aid to the unemployed as a deterrent to taking a job, which makes sense. Why work if you are getting more by staying unemployed? However, most want a permanent job that pays well. Extended unemployment benefits allow workers a longer time to search for a good job. If you want workers, you can pay them more. Several states have begun to reign in extended unemployment benefits. At the federal level, extended unemployment benefits are set to end on Labor Day, just as schools and daycare centers re-open, leading to an increase in (mostly) female labor force participation.

Fed Governor Lael Brainard gave a good summary of the central bank’s views. “There are a variety of reasons to expect an increase in inflation associated with reopening that is largely transitory,”, she noted, highlighting supply-chain bottlenecks, shipping delays, and container shortages. “If past experience is any guide, production will rise to meet the level of goods demand before too long,” she added. Supply–demand imbalances in the in-person services sector “are expected to be resolved within a few quarters with progress on virus control and the return of in-person schooling.” She emphasized that “a persistent material increase in inflation would require not just that wages or prices increase for a period after reopening, but also a broad expectation that they will continue to increase at a persistently higher pace.”